Banks' loan exposure to local governments and property developers is a far more serious and imminent threat to the mainland's financial system than shadow banking, according to Standard & Poor's.
In a report released yesterday, the credit ratings agency said shadow banking was "more a symptom than a cause" of emerging systemic risks to the country's banking sector and the wider economy.
Shadow banking, or unregulated credit offered by non-bank lenders, had grown in the country at an annual rate of 34 per cent since 2011, to reach 22.9 trillion yuan (HK$28.3 trillion) of credit at the end of last year, S&P said.
That is equivalent to 34 per cent of total loans in the banking sector and 44 per cent of national GDP last year.
The rapid rise of shadow banking and several high-profile defaults last year brought to light the risks of the underlying assets of wealth management products and trust loans, prompting regulators to raise the alarm and tighten scrutiny.
Compared with the Group of 20 most-industrialised countries and economies, where shadow banking accounted for an aggregate 111 per cent of their 2011 GDP, shadow banking is still not in a position to destabilise China's financial system because banks' capitalisation, earnings and liquidity profiles provide a "comfortable buffer" to absorb any possible hit, according to S&P.
Instead, a major threat comes from the regular banking sector's credit exposure to local-government financing vehicles and real estate companies.
"Chinese banks have already accumulated high credit risks on their balance sheets," said Liao Qiang, an S&P analyst and co-author of the report.
"The exposure to these segments (local governments and property) by the regular banking sector is already high. When the central government attempted to contain the risk, shadow banking boomed and continued to fuel excessive expansion of the segment."
The financing arms of local governments were major recipients of bank credit in the lending binge in 2009. Many of these financing arms have poor solvency, but credit losses have so far been low as regulators allow loans to roll over.
Without that extra support from the central government, bad loans would have surged.
S&P said the property market was another key risk to the country's financial system.
Speculative forces, fuelled by shadow banking credit, are on the rise, adding to the risk of an abrupt correction of the property market that could have a sizeable knock-on effect on the banking sector.